26 JULY 2013
Does A Change In Language Alter The Fundamental Truth?
By Gabriel Gan
It was a good fortnight for the global markets with the Dow Jones industrial Average (DJIA) at record territories while most other global indices, including key Asian indices, are fighting to emulate the performance of their US counterpart.
On 23 July, the DJIA set an intraday high of 15,604 points but close slightly lower at 15,564 points – still a record-breaking feat amid some stronger-than-expected earnings, upbeat economic data especially pertaining to the housing sector and, most importantly, US Federal Reserve Chairman Ben Bernanke’s comments that Quantitative Easing (QE) III will continue as long as the US economy warrants government support.
In a damage-control situation whereby the central bank chief had no choice but to soften his stance after declaring earlier that the stimulus measures could be reduced by the fourth quarter and may even end by mid-2014, he spooked markets into a selloff but his U-turn comments gave investors hope.
Once again, we can be very sure that investors are not prepared for a world without money-printing machines while, on the other hand, we may optimistically choose to believe that investors are pushing the DJIA to new records not because of Bernanke’s comments but more so because of improving US economic fundamentals.
If we continue to choose to believe in the latter, it is tantamount to believing that Santa Claus will climb down the chimney to deliver presents on Christmas Eve. Don’t forget that Santa Claus is too fat to go down the chimney just as no stimulus measures can last forever.
Strong Or Weak – The Dilemma?
Do investors want the US economy to be strong or hope that it will weaken?
This is one big dilemma that the market itself cannot answer because a strong economy will almost spell the end of the stimulus measures. While some data continue to make us think that the US economy may not be as strong as it is, others such as housing and labour data seem to confirm that the US economy is indeed on the mend and may get stronger by the end of the year.
The US economy is very much consumer-driven hence a strong labour market can only mean that more people get employed and consumption improves. When the latter happens, companies will ramp up production and will then hire more workers who will continue to spend. These patterns feed into one another hence there is every reason to believe that hiring in the US is heating up despite the unemployment rate continues to stay at 7.5 percent.
The labour data for the past two months show that more and more jobs are being created so the only explanation for the stubbornly-high unemployment rate is that the long-term unemployed are coming back into the job market in search of jobs. It is likely that the unemployment will start to fall in the coming months especially in the fourth quarter as companies hire in preparation for the end-of-year peak season.
It is good news for investors! An improving US economy means that economic fundamentals will finally catch up with stock market valuations. At current prices, the S&P 500 is trading at a valuation of 16.3 times – comparable to the level at mid-2010 – but just a whisker away from the 17.5 times in 2007 before the stock market crash.
If the US economy were to strengthen, QE III vanishes, only for the economy to weaken again, then it is good luck to investors. Half of the economists predict a cut in the bond-buying programme in September by about US$20 billion a month, which means that a cut more than the expected amount may trigger a selloff.
So do we want a weak economy so that QE III stays? From the way American investors are paying attention to the language used by Ben Bernanke, it is almost certain that they are clamouring for the stimulus to never end and to achieve this, the US economy must continue to drag its foot much to the detrimental of the health of the real economy. The Chinese are now biting the bullet and have been shunning away from large-scale stimulus measure and have adopted an approach tailored to boost sectors that require investments as opposed to the economy per se.
New Moves From China
During an official visit to the US, Minister of Finance Lou Jiwei told the world that China’s economy may expand less than the official target while slower growth “as low as 6.5 percent can be tolerable”. While the official target of 7.5 percent growth was made known in March, the finance chief declared that he is confident of achieving a 7 percent growth for this year.
Soon after, Lou’s boss, Premier Li Keqiang, quickly stepped in to reiterate China’s official growth policy of 7.5 percent for this year and 7 percent for the long-term growth of China. Why did Lou deviate from the official stance? Does he have the permission of his boss to even talk about 6.5 percent?
It is rather strange, but it seems that Premier Li is trying his best to ensure the 7.5 percent growth this year even as the latest manufacturing data in China for the month of June contracted. Does it mean that China will grow at 7.5 percent for the second half of this year despite the discovery of large amounts of fake trade invoices via Hong Kong?
While there will not be a large-scale stimulus, there is still some form of investments in the areas of a tax break for small businesses, reduced export fees and a pledge to accelerate railway construction and investment. This is a positive for SGX-listed Midas Holdings.
Even as China liberalized the fixing of interest rate from a government-dictated one to a system that is market-oriented, the property sector gets no reprieve as loans will not be approved for this particular sector that the government is holding onto tightly with an iron fist.
While this move seems to give the bigger banks more leeway in granting loans at an interest rate of their choice, China, being China, will never be able to shake off the habit of granting loans based on personal relationships although it is likely that smaller companies and even individuals who resorted to borrowing from the shadow banks may now get bank loans. Liberalizing interest rates may also mean that the smaller banks suffer from margin squeeze as they have to compete with the bigger banks for deposits while offering lower interest rates to borrowers. Worse still, the quality of the loans taken up by these smaller banks may deteriorate.
Words Count More Than Action?
We have seen how Mario Draghi helped to stop the European debt crisis from worsening by merely signing off on a blank cheque with his words – only his words. We have seen how a change in the language of Ben Bernanke has helped to engineer a U-turn in the US stock market. After Premier Li explicitly mentioned the growth targets of 7.5 percent for 2013 and 7 percent for the future, the Shanghai Composite Index rallied strongly.
All these, however, does not mean that QE III will not end. Neither does it mean that China’s days of blistering growth is not over. We shall see if valuations can catch up with stock market or if the stock market will come down to match valuations.